Brokers miss bus to the future

Australia’s stockbrokers passed up a great opportunity to reform their remuneration system and lift their profession to a higher plane when they successfully lobbied to exclude brokerage commissions from the new laws covering financial advice.

Preserving the traditional commission-based remuneration model in stockbroking locks the brokers into the old world that is suited to ageing baby boomers and their parents.

It is almost as though the brokers are yearning for the days 30 years ago when Australia’s broking industry was dominated by larger than life, colourful personalities who built and ran extremely successful firms. They were key players whose influence and connections were the fabric of the equity capital market.

The problem with preserving the commission-based system that underpinned the golden age of broking is that it fails to recognise the dramatic change in the operating environment and the changed demands of investors. Information is no longer the preserve of selected brokers. Just about anything and everything about shares and financial markets is instantly available to everyone.

The broker model of a base salary and commission on execution of share trades perpetuates the image of brokers as the single-asset-class financial advisers. That image was fine when the market rose 150 per cent between November 2003 and November 2007.

Shares are no longer the most important and dominant asset in many portfolios. In fact, some would argue that the entire ball game changed in 2008. Investors with large share portfolios lost half their wealth and started to question whether or not they should have had a more ­balanced mix of assets. It is clear that many Australians now regard cash as the most valuable asset at the moment, and not shares.

The Stockbrokers Association of Australia successfully convinced Financial Services Minister
Bill Shorten
there was no conflict in the commission model for brokers be­cause the fee was not paid by the issuer. It is claimed to be a fee-for-service model. The association also claimed that churning by brokers to generate more commission was not a common practice and wildly overstated as a problem. However, the brokers are being left behind as all around them shift to investment processes that include an examination of the risks and the rewards of each asset class. This approach to investing regards absolute return as more important than the return of a share portfolio relative to a weak sharemarket.

The fact is the commission-based remuneration model is the ­preserve of Anglo-Saxon countries and it is no longer the favoured approach in private banking or in the domestic wealth management companies. It has survived in Australia, the United States and the United Kingdom despite the conflict between the adviser, who is given a financial incentive to trade, and the client.

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Stockbrokers might have got off the hook on commissions but they will still be hit with the ban on ­product commissions. PwC’s Anthony James says brokers will need to restructure remuneration arrangements on margin lending, cash management and banking products, and other products sold to retail clients such as managed funds.

The draft legislation released yesterday for phase one of the Future of Financial Advice includes rules that have been part of the day-to-day operations of most financial planners for years.

It turns out the controversial opt-in clause, which forces planners to go back to their clients with annual updates and get them to recommit to being a paying client every two years, is not so bad after all.
John Brogden
at the Financial Services Council says the two-year time frame and the clarification that it will apply only to new clients makes the reform workable.

Shorten has managed to keep ­everyone happy but the industry still has its fair share of grey areas. Take the booming investment newsletter market, issued by about 10 providers and which has an estimated 50,000 paying subscribers.

Virtually all the major newsletter publishers take the view that their businesses must operate under an Australian Financial Services Licence (AFSL) in keeping with the Corporations Act, which seeks to regulate providers of “financial product advice".

Several lawyers who provide advice on this aspect of the law say that any report that contains a statement of opinion that could reasonably be regarded as intended to influence a person in making an investment decision needs an AFSL.

This is because the newsletters often contain a “qualitative judgment about, or an evaluation, assessment or comparison of, some or all of the features of one or more financial products".

However, there an exemption under the Corporations Act for the media, such as this newspaper, which is generally available and its principal purpose is not the provision of financial product advice. One newsletter that operates under the media exemption is Eureka Report, even though it promotes itself in Google web ads as offering expert investment advice.

Eureka Report used to have an AFSL, but its lawyer, who used to work at the Australian Securities and Investments Commission, advised it that it could operate without one ­utilising the media exemption.

Having an AFSL can be expensive. A holder needs to comply with various regulatory requirements including the need for professional indemnity insurance, being a member of an external dispute resolution scheme and having in place arrangements for the management of conflicts of ­interest.

The hedge funds that attacked the
Charter Hall Office REIT
were yesterday given a get-out-of-jail card by the
Macquarie Group
-led consortium’s cash bid for a portfolio of undervalued quality Australian office buildings.

Orange Capital, Luxor Capital and Point Lobos, which control about 19.9 per cent of the trust, were looking hopeless and forlorn after they pushed their case for a winding up of the trust a little too aggressively and to no avail.

It is doubtful they had the resources to buy enough stock to force a winding up. Now, they must be considered willing sellers into the bid although they will be hoping the independent directors of Charter Hall Office Management, a subsidiary of
Charter Hall Group
, will squeeze a few more cents out of the bidders.

The bid places an asset value on the entire trust of $1.725 million and a value on the Australian office buildings of about $1.2 billion, which is a 9 per cent discount to their asset value.

The bid has a number of elements that make the Macquarie consortium look smart and the Charter Hall Group even smarter.

It is best to look at the bid as a management buyout. Charter Hall’s 13.4 per cent stake in the trust is not included in the offer and Charter Hall will remain manager of the trust if the indicative proposal moves to a conclusion.

Charter Hall appears to have side-stepped the sticky corporate governance issues that engulfed
Valad Property Group
in January this year, when a consortium including chief executive
Peter Hurley
bid for Valad’s European assets.

Hurley had to step aside in favour of an interim CEO. The consortium’s offer was later withdrawn and Hurley resigned in April. Valad was bought by Blackstone.

By keeping its distance from the consortium, Charter Hall not only avoids the corporate governance issues and attendant conflicts, it can also remain open to offers from other parties.

The Macquarie-led consortium probably has a slight edge on any other potential bidders because Macquarie Group is the single largest tenant in No. 1 Martin Place, which is half owned by the trust and half owned by Macquarie Martin Place Trust.

Charter Hall appears to have kept an ace in its pack by reserving the right to vote on the proposal.

All up, this bid is probably good for the real estate investment trust sector because it draws attention to undervalued assets.

It might even get minds working on the opportunities for ­corporate activity among other listed trusts trading at a discount to net assets.

The whole sector jumped in value yesterday but the biggest beneficiary was the
DEXUS
Property Group, which spiked by about 3.8 per cent. By the close of trading, the DEXUS discount to net assets had been shaved to 18.81 per cent.

It is regarded as a sitting duck because it has the mix of assets in favour with hedge funds and other long-term buyers such as the Canadian pension funds and Singapore’s GIC.

That mix includes Australian office buildings and US industrial property.